Implementing Out of State Trusts November 8, 2017 1
The material appearing in this presentation is for informational purposes only and is not legal or accounting advice. Communication of this information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although these materials may have been prepared by professionals, they should not be used as a substitute for professional services. If legal, accounting, or other professional advice is required, the services of a professional should be sought. 2
Presenters Daniel Lorenzen, ESQ. Venable LLP Victor Shlionsky, CPA, MS Taxation Moss Adams 3
Agenda Background Trends with foreign to domestic trusts Factors to consider in picking a state California 4
Objectives Recognize the planning opportunities available for trusts established out-ofstate. Gain insight as to compliance with interstate trust reporting and taxation requirements. Identify implications for tax planning and tax preparation. 5
Why Discuss Now? Numerous states increasingly competitive with trust provisions While California, among others, increasingly unfavorable More substantial differences in tax rates between states Well established state trust laws Easier for individuals and trusts to move between states Trustee fees reasonable 6
Shift from Offshore to Onshore Implementation of CRS Adopted by OECD & traditional tax haven countries in 2014 Provides for automatic multilateral sharing of information gathered from financial institutions among all jurisdictions First exchanges (most of Europe and some offshore jurisdictions) started in 2017 Second round of commitments (Asia, Africa, etc.) begins in 2018 The US is satisfied that the information collected through FATCA, etc. FATCA is primarily for US Government benefit, and information sharing is on a bilateral basis only. US gathers extensive information FBAR, Form 3520, etc., but shares it with other countries on a more limited basis. 7
Shift from Offshore to Onshore (cont'd) Innovation level of US trust law Many features that used to be available through the laws of offshore trusts are now available domestically Asset protection Perpetuities Privacy - no disclosure of beneficial ownership Allocation of trust fiduciary liability - protector, investment, distributions Low taxes 8
Shift from Offshore to Onshore (cont'd) Federal tax no real advantages for US persons Disclosure to US tax authorities Form 3520 must be filed to disclose transfer of property to foreign trust Form 3520 must be filed every time a distribution is received from a foreign trust Transfers to foreign nongrantor trusts may be subject to a deemed recognition of gain 9
Shift from Offshore to Onshore (cont'd) Federal tax no real advantages for US persons (cont d) Accumulated income (UNI) is taxed to US person when received, according to the "throwback rule" The rules recapture the income as fully ordinary income at the highest marginal rate of the taxpayer An interest charge applies - equal to the rate for underpayments of tax, compounded daily A "default method" of calculating the tax on UNI distributions allows minimal increases in DNI from year to year to be deemed not subject to the interest charge Although the default method does not perfectly capture actual income, US taxpayers are hard pressed to find planning opportunities under these rules. 10
Onshore Trusts Nonresident Trusts: Taxation Undistributed income sourced to assets in state taxable Definition More conformity between states on definition of nonresident trusts & state sourced income compared to residency trusts Impact of income on distribution deduction 11
Onshore Trusts (cont d) Resident trusts Taxation All undistributed federal income sourced to state of residency Definition Different definitions per state Determining residency Nonconformity between states Fiduciary, grantor, beneficiary, other? Estate could have difference requirements California Determining factor is residency of fiduciary or noncontingent beneficiary If decedents estate, determining factor is residency of grantor Planning opportunity? 12
Onshore Trusts (cont d) Resident trusts (cont d) Constitutionality when minimal connections in state: Linn v. Illinois Department of Revenue Fielding vs. Minnesota Commissioner of Revenue Others 13
Considerations for Picking a State State law provisions 1. Trust length 14
Considerations for Picking a State State law provisions (cont d) 2. Flexibility Decanting Increasingly important consideration 15
Considerations for Picking a State State law provisions (cont d) 3. Creditor protection Rise of Domestic Asset Protection jurisdictions 16
Considerations for Picking a State (cont d) State law provisions (cont d) 4. Privacy - US jurisdictions don t typically report beneficial ownership There is no state law registration for trusts (cf. increasing registration requirements for private fiduciaries) Certain states have evolved to keep trust information private from beneficiaries, except in limited cases 17
Considerations for Picking a State (cont d) State law provisions (cont d) Privacy Although U.S. jurisdictions don t collect trust information in general, many civil law jurisdictions with new, statutory trust laws, do But, see 2016 FinCEN actions adopting geographic targeting orders for New York and Miami to require title insurance companies to report beneficial ownership information for high-end real estate purchases made with all cash Tip of the iceberg for the U.S.? 18
Considerations for Picking a State (cont d) State law provisions (cont d) 5. Tax Income tax filing and rates vary 18 states have estate and/or inheritance tax 1 Domicile of grantors, fiduciaries, and beneficiaries 1 Morgan Scarboro Does Your State Have an Estate or Inheritance Tax? May 2017 https://taxfoundation.org/state-estate-inheritance-tax/ 19
Implementation Steps Understand the client: Personal and business goals Domicile of grantor, fiduciary, and beneficiary Family Cash flow 20
Implementation Steps (cont'd) Methods: Express Situs Provisions Does the trust document expressly allow the Trustee to change the situs? Does the trust document allow for a change of Trustee, who may be located in a different situs, and is otherwise silent about situs? Decanting Provisions Is the trust in a jurisdiction that allows for decanting (i.e., not CA)? If not, can we do a common law decanting? I.e., does the trust document allow the Trustee to distribute in further trust? Non-Judicial Modifications Can some combination of the Settlor, the Trustee and the Beneficiaries modify the trust without court? California Probate Code Section 15404 Check for limitations such as material purpose, etc. Judicial Modification 21
Implementation (cont'd) Analyze the drawbacks: Audit Cost Control Location New Trust 22
Planning Opportunity for California Right circumstances - Contingent beneficiaries, nonca Trustees Significance for income tax Example? The client is a California resident who owns a business with worldwide income (some percentage of which may be California source) The client may wish for family members who do not reside in California to benefit from the income, and eventually the principal, through a trust structure The client does not want to make a taxable gift of the principal value of the business that generates the income The client may have used her lifetime exclusion amount The principal value of the business may be very large 23
Planning Opportunity for California (cont'd) Action steps Consider whether the client wishes to personally relocate to a low-tax state on a permanent basis Identify non-california fiduciaries Out of state trust companies in favorable jurisdictions Directed trust structures Investment Advisers Distributions Advisers Trust Protectors Consider whether an entity may serve in one or more of the fiduciary roles (See SD Special Purpose Entity statute) Federal tax effects - See Notice 2008-63 governing Private Trust Companies Consider California contacts for such an entity 24
Planning Opportunity for California (cont'd) Action Steps (cont'd) Identify non-california beneficiaries, or purely contingent California beneficiaries Consider Nongrantor trust structures The trust may pay more federal income taxes due to the compressed rate structure applicable to trusts The trust instrument must be drafted with care to avoid any of the powers triggering grantor trust status under IRC Sections 671-679 A California beneficiary who receives a distribution of accumulated income will pay deferred California taxes using a "throwback rule" similar to the federal one, but without the interest charge Consider incomplete gift structures Not a typical estate planning vehicle - the entire value of the trust will be includable in the client's gross estate Distributions made from the trust to other beneficiaries are taxable gifts to the client The client will retain some carefully drafted personal rights to direct the income during lifetime, and to appoint the balance at death 25
Planning Opportunity for California (cont'd) ING California's interest FTB indicated it would review policy on these in 2011 No noticeable action since New York The state invalidated favorable treatment of trusts in low-tax jurisdictions in 2014 If the grantor of the trust is a New York state/city resident, and the transfer to the trust is an incomplete gift, its income will be taxed to the grantor for New York City and State purposes 26
Planning Opportunity for California (cont'd) ING (cont d) Remaining Lines of Attack for California Legislative fix a la New York In audit, find that the facts and circumstances indicate that the California grantor controls the fiduciaries and therefore is one If the assets of the trust are somehow subject to the grantor's creditors, parallel provisions of bankruptcy laws may attribute ownership to a California grantor 27
Questions? 28